What If Legacy Pharmaceutical & Consumer Business Keeps Falling For Merck?

Merck‘s (NYSE:MRK) legacy pharmaceuticals and consumer business constitutes roughly 30% of the company’s value according to our estimates. Despite it being a segment that has seen a revenue decline in recent years, its value contribution remains high due to much higher sales compared to other reportable segments. The future of these products appears cloudy at best. Our current price estimate for Merck stands at $55, implying a discount of over 5% to the market price. However, there can be a downside of about 10% to our price estimate if Merck’s legacy pharmaceuticals and consumer business revenues continue to decline. To mitigate this risk, Merck is developing some promising drugs to treat cancer and hepatitis C. The market for both these diseases is significant, and currently the industry is witnessing strong R&D efforts from big pharma companies in this area.

What Does Merck’s Legacy Pharmaceutical And Consumer Business Include?

This segment includes Merck’s legacy products which are facing declining revenues due to competitive pressure from generics. It also includes revenues from non-reportable segments such as animal health and consumer care, along with revenues from the company’s relationship with AstraZeneca (AZLP) primarily relating to sales of Nexium and Prilosec. Animal health products include Nuflor antibiotic range for use in cattle and swine, Bovilis/Vista vaccine lines for infectious diseases in cattle and Estrumate for treatment of fertility disorders in cattle. Consumer healthcare includes foot care products, topical antifungal products and foot and sneaker odor/wetness products. Additionally, there are over-the-counter products such as non-drowsy antihistamines, medicines for occasional constipation, decongestant-free cold/flu medicine for people with high blood pressure, nasal decongestant spray, and drugs for frequent heartburn.

10% Downside If The Decline In Revenues Doesn’t Halt

Merck’s legacy pharmaceutical and consumer business revenues have declined from roughly $13.5 billion in 2010 to $12.7 billion in 2013. We expect the figure to continue to decline in 2014 and increase slightly thereafter. Our forecast is based on the expectation that consumer business and animal health growth will offset the decline in legacy drugs that have lost their patent protection. However, there is a chance that the sales from this segment continue to decline. If that happens, our price estimate can go down by approximately 10%. In other words, Merck will be a $50 stock if the segment’s revenues were to go down to $8.50 billion by the end of our forecast period.

To offset weakness in its legacy products and some other drugs, Merck is banking on its R&D pipeline. The company recently entered a partnership for Hepatitis C research. It also has high hopes for its oncology pipeline as discussed below.

What Will Offset Weakness In Legacy Products?

Merck recently announced a definitive agreement to acquire Idenix at $24.50 a share for cash, offering a hefty premium of about 240% over last Friday’s (i.e. June 6th) closing price. [1] The acquisition will strengthen Merck’s Hepatits C portfolio and help it stem the revenue decline resulting from patent expiry of major drugs. The company will be conducting phase 3 trials for a combination treatment for Hepatitis C, which could potentially rejuvenate the pharmaceutical giant’s revenue growth. The clinical data for a combination of drugs MK-5172 and MK-8742 has shown high cure rates among patients with genotype 1 of the disease, and this has encouraged Merck to move to phase 3 trials. Acquisition of Idenix could be a game changer considering the possibility that a combination treatment leveraging Idenix’s drugs could potentially reduce the treatment window to four to six weeks.

Merck is also directing some of its focus on developing immuno-oncology drugs to help stem the decline in its revenues. MK-3475 (lambrolizumab or, as it was just renamed, pembrolizumab) is Merck’s investigational PD-1 specific monoclonal antibody for the treatment of advanced malignancy.The drug essentially enables a patient’s immune system to detect cancerous cells that are otherwise extremely hard to identify. T cells can then target and kill these exposed tumor cells. In June 2013, Merck reported that 38% of cancer patients under trial responded positively to this drug. Investors have welcomed the company’s decision to investigate the drug’s effectiveness in combination with other investigational agents. The drug is currently being studied in 17 clinical trials involving over 4,000 patients across more than 30 types of cancer. [2] MK-3475 is a new class of drugs and could well be the future of cancer treatment. Bristol-Myers Squibb has a similar drug in clinical trial under the name Nivolumab and is expected to garner $6 billion in peak sales. Currently these drugs are being tested for melanoma (skin cancer), and if their usage expands to other cancer types, it could open a much bigger market for these pharmaceutical companies. Merck has already initiated a study to identify other cancer types where the drug can have a therapeutic effect. The company could revive its oncology division if MK-3475 is successful.

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